What is transfer Pricing?

Transfer pricing refers to the prices of goods and

services that are exchanged between companies
under common control. For example, if a
subsidiary company sells goods or renders
services to its holding company or a sister
company, the price charged is referred to as the
transfer price.
Transfer prices are almost inevitably needed
whenever a business is divided into more than
one department or division.
 Example of Transfer Pricing:
Take the following scenario shown in Table 1, in which Division A makes components for a cost of $30, and
these are transferred to Division B for $50. Division B buys the components in at $50, incurs own costs of $20,
and then sells to outside customers for $90.
 There are four methods of Transfer Pricing
 Variable Cost  Full Cost

 Negotiated price  Market Price

  

1) Variable Cost : 2) Full Cost :

A method in which transfer price sets equal to variable cost and share of
A method in which seller sets the transfer price equal to variable cost,
fixed cost, with or with out markup. Full cost pricing is a practice where
with or without markup. This method is selected when seller has an
the price of a product is calculated by a firm on the basis of its direct costs
excess capacity and low variable cost the external purchase price. Some
per unit of output plus a markup to cover overhead costs and profits.
companies add a markup on variable cost and some used lump sum
variable cost, it depends on the companies.
 

3) Market Price: 4) Negotiated price:

Market pricing is a strategy used to set prices according to This is a transfer price in which both selling and buying divisions
current prices in the market for the same or similar products or are agreed. This method helps to reduce conflict between divisions
services. but this is a time-consuming method.

 
Choosing of Method:

Firms can choose two or more methods

called dual pricing for different divisions.
Every method has some advantages and
some limitations, firms choose as per
desired requirements.
For the Choosing of Methods, firms follow the
below mentioned steps:

External Variable Cost: Capacity:

Supplier:

 If the variable cost greater than external
 If no external supplier then buy internally
price then buy Externally and no Transfer
then choose cost or negotiated price method
price.
 If there is external supplier then go forward
 If cost is less then external price then go
to second step.
forward to third step.
 If seller has excess capacity then buy
internally and transfer price is Variable or
Market price
 If the seller is at full capacity,
i) Contribution of External sale greater than
savings then Buy Externally.
ii) Contribution of External sale less than
savings then Buy internally and transfer
price is Market price.